STATEMENT OF PAUL J. YAKOBOSKI age 70 1/2, paying income tax on it, and then investing it on a non-tax Now, instead assume an objective of increased saving for the purpose of RESEARCH ASSOCIATE Endnotes STATEMENT OF PAUL j. YAKOBOSKI sheltered basis till the money is needed. retirement income in the future. The proposal does increase the incentive to EMPLOYEE BENEFIT RESEARCH INSTITUTE EMPLOYEE BENEFIT RESEARCH INSTITUTE 1Under current law individuals who are not active participants in a qualified save for retirement through an IRA-type of vehicle by allowing the individual BEFORE THE COMMITTEE ON WAYS AND MEANS employment-based retirement plan can make fully tax-deductible There is currently an excise tax of 15 percent on any income from tax- access to money beIbre retirement should it be needed for qualified purposes. U.S. HOUSE OF REPRESENTATIVES SUMMARY preferred contributionsretirement up to aplans $2,000combined maximum in per excess yearof to $150,000 an individual annually retirement (indexed In 1993, among the 53.6 million civilian workers not participating in any type JANUARY 31, 1995 for account inflation). (IRA). Individuals Individuals expecting who are active to be impacted participants by or thiswhose excise spouse tax would is an of employment-based retirement plan, only 6.3 percent reported having T-95 have active the participant incentive in to aroll qualified any IRA employment-based funds into an ADSA. planThey and could whose then adjusted make contributed to an IRA in the previous year. Therefore, 94 percent of those I am pleased to appear before you this morning to discuss the proposal for withdrawals from the ADSA at their discretion so as to not incur the excise tax The gross American income (AGI) Dreamdoes Savings not exceed Account$25(ADSA) ,000 (single proposal taxpayers) creates or a new $40,000 type of eligible to utilize a tax-deferred IRA choose not to do so. It is often speculated creating American Dream Savings Accounts (ADSAs) found in H.R. 6. My name on tax-preferred this amount. saving vehicle for individuals. As proposed, an ADSA is a less (married taxpayers filing jointly) may make a fully deductible IRA that this is due to a lack of money on the part of lower income workers, but is Paul Yakoboski. I am a research associate at the Employee Benefit Research restrictive type of individual retirement account (IRA). While this proposal contribution. Individuals who are active participants or whose spouse is an these results hold across different levels of income. Only 2 percent of those Institute (EBRI), a nonprofit, nonpartisan, public policy research organization creates a new saving vehicle for individuals to utilize, I would like to raise a active participant in a qualified employment-based plan and whose AGI falls Beyond these three scenarios, the advantage of a rollover depends upon what eligible for a tax deductible contribution in the lowest earning bracket (under based in Washington, DC. one between few anticipates issues$25,000 for consideration happening and $35,000 to by their (single the tax committee. taxpayers) rate between One andnow is between theand implication retirement $40,000 ofand age. such a $5,000 annually) contributed to an IRA. While the contribution rate among If saving $50,000 one expects vehicle (married to forbetaxpayers retirement in a lowerfiling income tax bracket jointly) security, in may retirement, and make more a fully then fundamentally deductible one would , IRA be eligible higher earners is greater, the vast majority still do not participate. EBRI has been committed, since its founding in 1978, to the accurate statistical whether contribution the objective of less than of ADSAs $2,000 is and increased a nondeductible retirement IRA saving contribution or increased for the better off leaving the funds in the existing IRA. If, however, one anticipates Seventy-six percent of those with earnings of $50,000 or more and not analysis of economic security issues. Through our research we strive to saving in general? tax balance, rates increasing as follows. over The time, $2,000then maximum it would deductible make sense deduction to roll over is reduced into an by $1 participating in an employment-based plan did not contribute to an IRA. contribute to the formulation of effective and responsible health, welfare, and ADSA. for each $5 of income between the AGI limits. Individuals who are active retirement policies. Consistent with our mission, we do not lobby or advocate If the objective is increased saving in general, a question to be asked then participants or whose spouse is an active participant in a qualified An additional reason hypothesized for low participation rates among those specific policy solutions. regards employment-based the degree to plan which and individuals whose AGI is areatlikely least $35 to utilize ,000 (single the newly taxpayers) created or None of the money rolled over would Statem represent ent new additions to saving. It eligible is that individuals, especially lower income individuals, are reluctant vehicle at least , $50 and,000 this (married feeds into taxpayers the question filingofjointly) whether may it would only make generate would all merely be a shift of existing saving from IRAs to ADSAs. These to put their saving in a vehicle where it is beyond their reach (without The American Dream Savings Account proposal creates a new type of tax- additional saving. The longer the investment horizon of an individual, the nondeductible IRA contributions of up to $2,000; earnings on the rollovers would generate tax revenue for the government at the time of significant tax penalty) should they need it before retirement age. The ADSA preferred saving vehicle for individuals. As proposed, an ADSA is a less nondeductible contribution are tax deferred until distributed to the IRA rollover more attractive but would will mean be saving less tax through revenuean in ADSA. the future. Such a shift would proposal would ease such concerns by allowing access to the money after five Before the restrictive type of individual retirement account (IRA). 1 Anyone may make a holder. IRAs can also be established as rollover vehicles for lump-sum have potentially noteworthy implications for retirement income security. years for first time home purchase, education expenses, or medical expenses. contribution of $2,000 annually, irrespective of income or pension An distributions individual from in theemployment-based 28 percent tax bracket pension saving plans$2,or 000other a year IRAs. for five years After five years, such money would be available tax free for the qualifying This should result in increased IRA participation through ADSAs, but again the participation earning 6 percent status. annually The ,contribution say toward is the withdown after payment tax dollars on , a but first investment home, purposes. To the extent that such withdrawals occurred, it would be at the 2Distributions from H an ouADSA se Ways would andalso Means be tax Committee exempt in the event of the death question is by how much? This is very hard to predict with precision. Again, earnings would have accrue $600taxmore free in subject an ADSA to conditions. than if he saved All distributions on a non tax-preferred from such an price of future retirement income. This represents a dramatic shift of policy or disability of the account owner. the fact that individuals are only allowed to withdraw money without tax account basis ($12,000 are tax versus exempt $11,400). if they occur However at or , after givenage that59ADSA 1/2 or account the account balances has objective away from saving for retirement income security to saving in penalty 3Distributions under a from limited IRAsnumber are taxedof as circumstances, ordinary income and in then theonly year after received, five been cannotopen fall for below at least $1,000 five with yearsa distribution, and the distribution he wouldis actually used for have first time $400 more general. Under the proposal, significant sums of money that had been years except , may for the stillportion discourage of thethese total types IRA distribution of individuals that(current is attributable eligibles to at his disposal by saving outside the ADSA. home accumulated purchase,in tax-preferred education expenses vehicles , orearmarked medical expenses. for retirement 2,3 Furthermore income , choosing nondeductible not tocontributions, participate) from whichparticipating are excludable in anfrom ADSA. gross income. Hearing on would be made available for other purposes. It can be argued that some of the money in an existing IRA (whether the result of regular tax deductible Taxable distributions prior to age 59 1/2 are subject to a 10 percent penalty tax, The same individual saving at the same rate for 18 years instead of 5 years, say contributions or of the rollover of a lump-sum distribution from an spending, such as a home purchase or additional education for the owner, Any unlessworker they are is currently taken as allowed part of atoseries make ofanequal after-ta payments x contribution made for of the up to life for a child's education, would have $65,500 in the ADSA compared with $55,100 would enhance retirement income security; however, the shift in emphasis employment-based plan such as a 401(k)) would be eligible for rollover into an $2,000 (or life expectancy) to an IRA as of now such structured. employee Earnings and his or accumulate her beneficiary tax ,deferred or the and IRA by saving on a non tax-preferred basis. Given the above, it is not clear how from retirement saving to generic saving remains important because of the ADSA. owner 4dies Income or becomes tax would disabled. be paid on the roUover amount at the time of income tax is not paid on them until distribution. While hard data on the use of Savings and Investment advantageous someone with a relatively short saving horizon would actually potentially dramatic implications for retirement income in the future. rollover, but future earnings would accrue tax free and any distribution would IRAs on an after-tax basis are lacking, it seems that such behavior is relatively 4It is not clear how the rollover of IRAs consisting of after tax contributions American Dream Savings Accounts find such a saving vehicle, but an investor with a longer saving horizon is rare. The existence of ADSAs would create an increased incentive for such not be taxed if qualified as outlined above. would be treated for tax purposes. likely to find it very attractive. Conclusion saving as the mechanics are essentially the same with the added bonus that the 5H.R. 6 stipulates that for a distribution to be a "qualified special purpose by The American Dream Savings Account proposal creates a new type of tax- While this proposal creates a new option for individuals to utilize in saving, earnings are not taxed, even at distribution (and there is also the availability distribution," it shall not include any payment or distribution to the extent If the objective is increased saving for the purpose of retirement income, the both preferred for retirement saving vehicle and other for individuals. designated As purposes proposed , ,I would an ADSA like is to araise less a few to withdraw the money before age 59 1/2 for qualified reasons). such payment or distribution reduces the balance of the amounts in proposal does increase the incentive to save for retirement through an IRA- restrictive type of individual Paul Yakoboski, retirementResearch account Associate (IRA). The longer an issues for consideration by the committee. One is the implication of such a ADS accounts of the taxpayer below $1,000. type of vehicle by allowing the individual access to money before retirement individual's investment horizon, the more attractive will be saving through an saving Finally, vehicle the ADSA for retirement proposal would income allow security individuals , and more with fundamentally an existing IRA to roll Employee Benefit Research Institute 6The minimum amount that must be paid each year is determined by dividing should it be needed for qualified purposes. Over 90 percent of those eligible to ADSA. In addition, individuals eligible to make tax-deductible IRA whether over theirtheIRA objective into an of ADSA. ADSAs Income is increased tax would retirement be paid saving on the or rollover increased amount utilize the account a tax-deferred balance by IRA the choose applicable not tolife do expectancy. so. It is often The speculated applicable thatlifethis is contributions, but who have not done so in the past, may find the ADSA option saving at the time in general? of rollover, but future earnings would accrue tax free and any due to a lack of money and a reluctance to put saving in a vehicle where it is expectancy is the life expectancy of the employee, or the joint life attractive since it allows access without tax penalty to the savings before distribution would not be taxed if qualified as outlined above. (It is not clear beyond one's reach (without significant tax penalty) should it be needed expectancies of the employee and the employee's designated beneficiary, if Washington, D.C. retirement if the money is used for a qualifying reason (first time home Assuming how the rollover for the of moment IRAs consisting an objective of after-tax of increased contributions saving in would general,be atreated before any. The retirement. life expectancy The ADSA of the proposal employeewould and/or ease the such employee's concerns spouse by allowing can be purchase, education expenses, and medical expenses). Finally, the ADSA for tax purposes.) Such a rollover would be permitted no matter what the question to be asked then regards the degree to which individuals are likely to access recalculated to the annually; money after however five ,years the for life first expectancy time home of apurchase beneficiary , education other proposal source of would the IRA allow money individuals , whether with the result an existing of regular IRA totax-deductible roll over their IRA utilize the newly created vehicle and this feeds into the question of whether it expenses than a spouse or medical cannot expenses. be recalculated. This should result in increased IRA into an ADSA, meaning that literally hundreds of billions of dollars in contributions or of a rollover of a lump-sum distribution from an would generate additional saving. If an individual were to save $2,000 a year 31 January 1995 participation through ADSAs, but again the question is by how much given "retirement savings" would be eligible for rollover into ADSAs. This for employment-based five years on a nontax retirement preferred plan such basis, assay a 401(k). toward the Thisdown meanspayment that literally on a that money is locked up for five years and then only accessible for certain first represents home, a hedramatic would have shift $11 of ,400 policy (assuming objective a away 6 percent from saving rate of for return and a hundreds of billions of dollars in "retirement savings" would be eligible for purposes. retirement income security to saving in general, with potentially dramatic rollover into ADSAs. Over the period 1977-1992, almost 119 million tax filers 28 percent tax bracket). If the same saving was done through an ADSA, the individual claimed a deduction would havefor$12 IRA ,000 contributions at the end of andfive theyears amount in his claimed accountfor , a gain of implications for retirement income in the future. Finally, the ADSA proposal would allow individuals with an existing IRA to roll deduction was over $252 billion. Rollover contributions to IRAs are even more $600. The question then is whether such gain is sufficient incentive for over their IRA into an ADSA. Income tax would be paid on the rollover amount Theindividuals views expressedto intie thisup stateme their nt money are solely in thos an e ofADSA? the authorIf athe nd sh money ould not is be needed attributed before to the significant in terms of dollars. In the 4-year period of 1987-1990 alone, 11.2 at the time of rollover, but future earnings would accrue tax free and any Employee Benefit Research Institute, its officers, trustees, sponsors, or other staff. The Employee Benefit five million yearsrollover , it would contributions be inaccessible were without made totax IRAs penalty. , totaling In $220 addition billion. , the distribution would not be taxed if qualified as outlined above. Such a rollover Research Institute is a nonprofit, nonpartisan, public policy research organization. individual could actually withdraw only $11,000 from the ADSA since the would be permitted whether the source of the IRA money was regular tax For account some balance individuals, is not the allowed tax gain to fall from below such $1 a ,000 rollover withwould a withdrawal. create a 5 strong deductible contributions or the rollover of a lump-sum distribution from an incentive to take advantage of the opportunity. Among those with such an Therefore, more money that can actually be used toward a down payment employment-based retirement plan such as a 401(k). This means that literally incentive would be individuals who already planned to tap into the IRA in the would be available by saving outside the ADSA ($11,400) than within the ADSA hundreds of billions of dollars in "retirement savings" would be eligible for future for one of the qualifying reasons, for example, a parent who planned to ($11,000) in this instance. rollover into ADSAs. Over the period 1977-1992, almost 119 million tax filers access some of their account in 10 years to finance a child's education. By claimed a deduction for IRA contributions, and the amount claimed for rolling over into an ADSA, they would avoid the 10 percent penalty tax at the llowever, with a longer investment horizon, such as one may have when deduction was over $252 billion. Rollover contributions to IRAs are even more point they took money out for the education expenses. saving for a child's college education, the financial advantage of saving significant in terms of dollars. In the 4-year period of 1987-1990 alone, there through an ADSA would increase. Assume an individual again saves $2,000 per were 11.2 million rollover contributions made to IRAs, totaling $220 billion. IlL& participants must commence benefit payments by April 1 of the calendar year, only now he saves this amount for 18 years. (Again, he is in the 28 year following the calendar year in which they reach age 70 1/2. The penalty percent tax bracket and earns a rate of return of 6 percent.) In this instance, For some individuals, the tax gain from such a rollover would create a strong for failure to make a required distribution of (at least) the correct amount is a the individual would have $65,500 in the ADSA after 18 years, compared with incentive to take advantage of the opportunity. However, none of the money nondeductible excise tax of 5O percent of the difference between the minimum $55,100 by saving on a non tax-preferred basis. The advantage of such a rolled over would represent new additions to saving. It would all merely be a required amount and the actual distribution. 6 An individual who did not want saving vehicle becomes more pronounced as the time horizon of the investor shift of existing saving from IRAs to ADSAs. These rollovers would generate increases. Given the above, it is not clear how advantageous someone with a the money till a later age would find it to his advantage to roll the money into tax revenue for the government at the time of rollover but would mean less tax an ADSA where it would grow tax free (after payment of income tax at the time relatively short saving horizon would actually find such a saving vehicle, but revenue in the future. Therefore, under the proposal, significant sums of of an rollover) investor till withthe a longer time ofsaving distribution. horizon There is likely would to find be no it very penalty attractive. for funds money that had been accumulated in tax-preferred vehicles earmarked for left in the account after age 70 1/2. This is better than taking a distribution at retirement income would be made available for other purposes. This would Suite 600 represent a dramatic change in policy objective. 2121 K Street, NW Washington, DC 20037-1896 202-659-0670 Fax 202-775-6312